Inventory — valuation, FIFO, AVCO & NRV
Inventory is stock you hold to sell, or materials you will use in production. In FA you must value it correctly, because closing inventory changes both profit and the statement of financial position. This page uses simple language, step-by-step numbers, and the traps examiners love.
What you must be able to do in the exam
- Know what counts as inventory (and what does not)
- Value inventory using FIFO and weighted average (AVCO)
- Apply lower of cost and net realisable value (NRV)
- See the effect on cost of sales and profit when closing inventory changes
- Avoid mixing continuous and periodic average methods in one answer
1. What is inventory? (keep it simple)
Under the idea in IAS 2 Inventories, inventory is assets held for sale in the ordinary course of business, in the process of production, or materials/supplies to be consumed in production or services.
Examples: finished goods in a shop, raw materials in a factory, work-in-progress, goods bought for resale.
Usually not inventory: machines you use for years (those are PPE under IAS 16), or long-term investments.
Tutor tip
If you can sell it in the normal trading cycle, or it will become something you sell, think inventory. If you use it for years to run the business, think non-current asset.
2. Why valuation matters (one picture)
In a simple trading business:
| Opening inventory | + |
| Purchases | + |
| Closing inventory | − |
| Cost of sales | = |
If closing inventory is higher, cost of sales is lower, so gross profit is higher. If closing inventory is lower, profit falls. That is why the examiner cares about the method and about NRV write-downs.
3. What is “cost”?
Cost includes purchase price and costs to bring inventory to its present location and condition (for example import duties, transport inwards that are part of getting stock ready).
Usually exclude from cost: abnormal waste, storage costs (unless necessary in production), selling costs, admin overheads that are not production-related.
FA questions often give you unit costs already — then your job is FIFO/AVCO and NRV, not rebuilding full absorption cost from scratch.
4. FIFO — first in, first out
Idea: You assume the oldest goods are sold first. Closing inventory is made of the newest purchases.
This is an assumption for valuation. It does not mean the warehouse literally always sells the oldest box first — but for the calculation, we follow that rule.
Full worked example
| Date | Detail | Units | Cost per unit (Rs.) |
|---|---|---|---|
| 1 Jan | Opening inventory | 10 | 5 |
| 10 Jan | Purchase | 20 | 6 |
| 20 Jan | Sold | 18 | — |
Units left = 10 + 20 − 18 = 12 units.
Under FIFO, the 18 sold come first from the opening 10 @ 5, then 8 from the purchase @ 6.
Closing inventory (FIFO) = remaining from the newest layer:
- All 12 remaining units are from the purchase @ 6? Wait — carefully:
- Sold: 10 @ 5 + 8 @ 6. Left from purchase: 20 − 8 = 12 @ 6.
- Closing value = 12 × 6 = Rs. 72.
(If sales were smaller, you might still have some old units left — always peel layers from the oldest first for issues, and leave the newest for closing stock.)
5. AVCO — weighted average cost
Periodic weighted average (common in FA):
Average unit cost = total cost of goods available for sale ÷ total units available.
Then: closing inventory = units left × average unit cost.
Cost of sales = units sold × average unit cost (same average).
Same numbers as above
- Total units available = 10 + 20 = 30
- Total cost = (10 × 5) + (20 × 6) = 50 + 120 = 170
- Average = 170 ÷ 30 = Rs. 5.666… per unit
- Closing 12 units ≈ 12 × 5.667 = Rs. 68 (rounding as the question requires)
Exam trap
Do not mix a “running” continuous average (recalculated after every purchase) with a single period-end average unless the question asks for continuous AVCO. Read the method name carefully.
6. Lower of cost and NRV (this is mandatory thinking)
Rule: Inventory is measured at the lower of cost and net realisable value.
NRV = estimated selling price in the ordinary course of business, minus estimated costs to complete and costs to sell.
Example: Cost Rs. 80. Expected selling price Rs. 90, selling costs Rs. 15. NRV = 90 − 15 = 75. Inventory must be shown at 75, not 80. Write-down of 5 is an expense (reduces profit).
If different product lines have different NRVs, apply the test in a way the question requires (often line by line for damaged or slow items, not “average everything into one blob” to hide a loss).
Common mistakes
- Using selling price alone and forgetting selling costs when calculating NRV.
- Writing inventory up above cost because NRV is higher — you do not value above cost under this rule.
- Leaving obsolete stock at full cost with no NRV thought.
7. Journals you should recognise
| Situation | Typical idea |
|---|---|
| Purchase of inventory on credit | Dr Inventory (or purchases) / Cr Payables |
| Year-end closing inventory (if using periodic purchases account) | Dr Inventory (SFP) / Cr Cost of sales (or closing inventory in P&L working) |
| NRV write-down | Dr Expense (or cost of sales) / Cr Inventory (or allowance) |
Exact account names follow the question’s ledger style. The logic matters more than the label.
8. Quick comparison sheet
| FIFO | AVCO (periodic) | |
|---|---|---|
| Closing stock made of | Newest costs | Average of all costs in the pool |
| When prices are rising | Closing stock higher; COS lower | Closing stock between old and new |
| FA focus | Layer calculation | Total cost ÷ total units |
Practice quiz
Important references
- ACCA FA syllabus & study guide
- IAS 2 Inventories (official standard overview)
- Inventory control checklist (workplace controls for professionals)
- FA Study Hub
Tutor habit: after FIFO and AVCO, always ask “Is NRV lower?” on damaged or slow lines. That one question saves marks.